Capital Budjeting Update-13(Raju Reddy)

8/10/2019 Capital Budjeting Update-13(Raju Reddy)

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ABSTRACT

The project titled CAPITAL BUDJETING IN DR.REDDYS LABORATORIES

LTDaims at evaluating the capital budjeting or investment decisions to set up a facility at

DR.REDDYS LABORATORIES LTDfor manufacturing the drugs for supplies directly from

bulk units.

The following capital budjeting techniques are used for evaluation assuming 15% as

discounting factor.

Non-Discounting Techniques like PAY BACK PERIOD (PBP), AVERAGE RATE OF

RETURN (ARR).

Discounting Techniques like NET PRESENT VALUE (NPV), INTERNAL RATE OF

RETURN (IRR), and PROFITABILITY INDEX (PI).

Capital budjeting or investment decisionsare are of considerable importance to the firm.

Since they tend to determine its value by influencing its growth,profitability and risk.


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CONTENTS

CHAPTER NO. NAME OF THE CONCEPT PAGE NO.

1.

Introduction

Objective of the study

Need of the study

Research Methodology

Scope of the study

Limitation of the study

Importance of the study

2. Industry & Company Profile

3. Review Of Literature

4. Data analysis and Interpretation

5. Findings & Suggestions

6. Conclusion

Bibliography


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CHAPTER1

INTRODUCTION


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INTRODUCTION

Capital budgeting is an essential part of every companys financial management. Capital

budgeting is a required managerial tool. One duty of financial manager is to choose investment

with satisfactory cash flows with high returns. Therefore a financial manager must be able to

decide whether an investment is worth undertaking and able to decide and be able to choose

intelligently between two or more alternatives.

Capital budgeting involves the planning and control of capital expenditure. It is the process of

deciding whether or not to commit resources to a particular long term project whose benefits

are to be realized over a period of time.

A capital budgeting decision is defined as the firms decision to invest its current funds

efficiently in the long-term assets in anticipation of an expected flow of benefits over a series

of years. The firms investment decisions would generally include expansion, acquisition,

modernization, and replacement of the long-term assets. They are the assessment of future

events, which are difficult to predict. It is really complex problem to estimate the future cash

flow of an investment.

The investment decision of a firm is generally know as Capital Budgeting or Capital

Expenditure Decision. Capital budgeting is also known as Investment Decision Making,

Capital Expenditure Decisions, Planning Capital Expenditure and Analysis of Capital

Expenditure.

Capital budgeting is finance terminology for the process of deciding whether or not to

undertake an i nvestment project.

A logical prerequisite to the analysis of investment opportunities is the creation of investment

opportunities. Unlike the field of investments, where the analyst more or less takes the

investment opportunity set as a given, the field of capital budgeting relies on the work of

people in the areas of industrial engineering, research and development, and management

information systems (among others) for the creation of investment opportunities. As such, it is

important to suggest that students keep in mind the importance of creativity in this area, as well

as the importance of analytical technique.

Because a project is financially sound, it must be ethically sound, right? Well . . . the question

of ethical appropriateness is less frequently discussed in the context of capital budgeting than

that of financial appropriateness.


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Budgeting requires the company to look ahead and formalize future goals. It is the planning

process used to determine whether an organizations long term investments such as new

machinery, replacement machinery, new plants, new products, and research development

projects are worth pursuing. It is budget for major capital, or investment, expenditures.

Capital budgeting techniques based on accounting earnings and accounting rules are sometimes

used - though economists consider this to be improper - such as the accounting rate of return,

and return on investment.


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OBJECTIVES OF THE STUDY

To know the important differences, that can arise in evaluating projects when using Net

Present Value (NPV), Internal Rate of Returns (IRR), Profitability Index(PI).

To analyze the strengths and weakness of existing Techniques in capital budgeting.

To evaluate capital projects using traditional methods of investment appraisal and

discounted cash flows methods.

To make recommendations and to improve further process of capital budgeting

To measure the profitability of the project by considering all cash flows.


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NEED OF THE STUDY

The project study is undertaken to analyze and understand the Capital Budgeting

process in Dr. Reddys Laboratories Ltd, which gives mean exposure to practical

implication of theory knowledge.

To know about the companys operations of using various capital budgeting techniques.

The financial department can implement and can get positive results by maintaining

proper financial reports.

To analyze the proposal for expansion or creating additional capacities

To make financial analysis of various proposals regarding capital investment so as to

choose the best out of many alternatives proposals.


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METHODOLOGY OF THE STUDY

The data is collected from Dr. Reddys Laboratorywith the help of:

Secondary data

Secondary data:-

It is obtained from capital budget manuals of Dr. Reddys Laboratories ltd.

Accounting manuals, and Website of the Dr. Reddys Laboratories ltd.

Books, journals, reports and other published sources of company.

DATA ANALYSIS TECHNIQUES:

Pay back period

Accounting Rate of Return

Profitability Index

Net Present Value

Internal Rate of Return.


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SCOPE OF THE STUDY

Preparation of capital budgeting is an important tool for efficient

and effective managerial decisions.

So in every organization they have to examine the capital budgeting process, therefore the

financial manager must be able to decide whether an investment is worth undertaking and able

to decide and be able to choose intelligently between two or more alternatives.

The process by which companys appraise investment decision, in particular by which

capital resources are allocated to specific projects.

Capital budgeting requires firms to account for the time value of money and project

risk, using a variety of more or less formal techniques. Capital budgeting decisions affect the profitability in terms of interest of the firm. They

also have a bearing on the competitive position of the enterprise. Its a diversification

burden

Capital investment involves cost and the majority of the firms have scarce capital

resources.

Capital budgeting is a complex process as it involves decisions relating to the

investment of huge resources for the benefit of achievement in future as it is always

uncertain.

Understanding the importance of the capital budgeting in Dr. Reddys Laboratories Ltd.


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LIMITATION OF THE STUDY

The study is conducted in short period. The time period of study has been limited to less

than 45days. The period is small to study the practical investment decision of a

company like Dr. Reddys Laboratories ltd.

It does not consider all the new unapproved schemes.

The study is conducted with the available data, gathered from annual reports of Dr.

Reddys Laboratories ltd.

The formula has been used according to the availability of the data.

All the techniques of capital budgeting presume that various investment proposals under

considerations are mutually exclusive which may not practically be true in some

particular circumstance.

Uncertainty and risk pose the biggest limitation to the technique of capital budgeting.

Since the procedures and policies of the company does not allow disclosing of all

financial information and has to be completed with the available data collected with the

maximum effort.


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IMPORTANCE OF THE STUDY

Capital budgeting is of paramount important in financial decision making:

Decisions affect the probability of the firm, as they also have a bearing on the

competitive positions of the enterprises.

A capital expenditure decision has its effect over a long time and inevitable affects the

company future cost structure.

The capital investments firm acquires the long-lived assets that generate the firms

future cash flows and determine its level of profitability.

Proper capital budgeting analysis is critical to a firms successful performance because

capital investments decisions can improve cash flows.

Capital investment involves cost of majority of the firms have scarce capital resources.

Capital decisions are not easily reversible, without much financial loss to the firm.

To make financial analysis of various proposals regarding capital investment so as to

choose the best out of many alternatives proposals.


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CHAPTER - 2

INDUSTRY & COMPAY PROFILE


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PHARMACEUTICAL INDUSTRY PROFILE

The Pharmaceutical Industry develops, produces and markets drugs licensed for use as

medications. Pharmaceu tica l companies can deal in generic and/or brand medications.

They are subject to a variety of laws and regulations regarding the patenting, testing and

marketing of drugs. The main aim of a particular Pharmaceutical Industry is to develop

research and distribute drugs in order to provide health care for the people in the

society. The Pharmaceutical Industry like other industries is subjected to follow

certain rules and regulations.

The Indian Pharmaceutical I ndustry is asuccess

story providing employment f or mil li ons and

ensuring that essenti al drugs at aff ordable pri cesare avail able to the vast population of the sub-

continent Richand Gerster

The Pharmaceutical Industry needs to follow rules about patent, marketing as

well as testing of drugs that are scheduled to come to the market as medicines. Since

the inauguration of the Pharmaceutical Industry in the 19th century, it has covered a long way

and now it has become one of the most influential and successful industry in the world with

both controversy and praise on its part.

Pharmaceutical Industry is very much dependent upon the developments and discoveries that

are made to search new types of drugs and also to search for new kind of medicines. One can

also differences within the industry regarding the same drug or report and different companies

with in the Pharm aceu tical Indus try lo ok to foll ow dif feren t paths for the same thing.

Drug Discovery and Drug Innovation are two very aspects in the Pharmaceutical Industry:

DRUG DISCOVERY:

Drug Discovery is a process through which potential drugs are designed or discovered. It has

been observed in the past that most of the drugs were invented by means of isolating the active

component from remedies which are traditional in nature or through another kind of discovery

known as serendipitous discovery.


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DRUG DEVELOPMENT:

This process is taken forward after the discovery is done and a th ing is identi fied as a

potential drug. The development takes place immediately after that as the

component is turned into a medicine. So this is also considered as a very

importan t process an d has great importance in the Pharmaceutical Industry. For the first

time ever, in 2006, global spending on prescription drug stopped $643 billion, even as

growth slowed somewhat in Europe and North America. The United States

accounts for almost half of the global pharmaceutical market, with $289 billion

in annual, sales followed by the EU and Japan. Emerging markets such as China.

Russia, South Korea and Mexico outpaced that market, growing a huge81 percent.US pro fi t

growth was maintained even whilst other top industries saw slowed or no growth.Despite this, the pharmaceutical industry is and has been for years the most

profitable of all businesses in the U.S. In the annual Fo rtune 500 survey, the

pharmaceutical industry topped the list of the most profitable industries, with a

return of 17%on revenue.

Indian Pharmaceutical Industry today is the front runner of Indiasscience-based industry with

wideranging capabi li ti es in the complex field of drug manufacture and technology. A

highly organized sector, the Indian Pharmaceutical Industry is estimated to be

worth $4.5billion, growing at about 8to9persent annually. It ranks very high in

the world, in terms of technology, quality and range of medicines manufacture.

From simple headache pi l ls to sophist icated ant ib io t i cs an d co mp le x ca rd ia c

compounds, almost every type of medicine is now made indigenously.

INDIAN PHARMECUTIAL INDUSTRY:

It plays a key role in promoting and sustainingdevelopment in the vital field of medicines, boasts of

quality producers and many units approved by

regulatory authorities in USA and UK. International

companies associated with this sector have stimulated

assisted and spread headed this dynamic development

in the past 53 years and helped to put India on the

Pharmaceutical map of the world.


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The pharmaceutical sector is highly fragmented with more than 20,000 registered units. It has

expanded drastically in the last two decades. The leading 250 pharmaceutical companies

control 70% of market with market leader holding nearly7%of the market share. It is an

extremely fragmented market with seven price competition and government price control. The

pharmaceutical industry in India meets around 70%of the countrysdemand for bulk drugs,

drug intermediates, pharmaceutical formulations, chemicals, tablets, capsules, orals and

injectibles. There are about 250 large units and about 8000 Small Scale Units, which form the

core of the pharmaceutical industry in India (including 5Central Public Sector Units). These

units produce the complete range of pharmaceutical formulations, i.e., medicines ready for

consumption by patients and about 350 bulk drugs. i.e.,chemicals having therapeutic value and

used for production of pharmaceutical formulation.

Manufactures are free to produce any drug duly approved by the Drug Control Authority.

Technologically strong and totally self-reliant, the pharmaceutical industry in India has low

costs of production, low R&D costs, innovative scientific manpower, strength of national

laboratories and an increasing balance of trade. The Pharmaceutical Industry, with its rich

scientific talents and research capabilities, supported by Intellectual Property regime is well set

to take on the international market.

US PHARMACEUTICAL INDUSTRY:

The United States in the worldslargest market for Pharmaceuticals and the world leader in

biopharmaceutical research. U.S. firms conduct 80 percent of the worldsresearch and

development in biotechnology and hold the intellectual

property rights to most new medicines. In 2010, the

pharmaceutical sector employed approximately 272000

people and according to the Pharmaceutical Research and

Manufactures of America (PhRMA), those manufacturesspent $67.4 billion on research and development in 2010.

The U.S. market is the worldslargest free-pricing

market for pharmaceutical and has a favorable patent and

regulatory environment. Product success is largely based

on competition in product quality, safety and efficacy,

and price. U.S. government support of biomedical research, along with its unparalleled

scientific and research based innovative biotechnology sector, make the U.S market the

preferred home for growth in the pharmaceutical industry.


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PHARMACEUTICAL INDUSTRIES IN INDIA:

Some of the below list of the Pharmaceutical industries in India are as follows:

Dishman Pharmaceuticals

Elder Pharmaceuticals

J B Pharmaceuticals

Torrent Pharmaceuticals

Sun Pharmaceuticals

Ranbaxy India

Cadila Pharmaceutical Limited

Wockhardt

Strides Arcolab

IPCA Laboratories

Alembic

Amrutanjan

Virchow Laboratories

Polydrug Laboratories

Dr. Reddy?s Laboratories

Aurobindo Pharma

Jubilant Organosys

Astrazeneca Pharma

Divis Laboratories

Merck Ltd.

ADVANTAGE INDIA:

COMPETENT WORKFORCE:

India has a pool of personnel with high managerial and technical

competence as also skilled workforce. It has an educated work force and

English is commonly used. Professional services are available.

COST-EFFECTIVE CHEMICAL SYNTHESIS:

Its track record of development, praticularly in the area of improved

cost-beneficial chemical synthesis for various drug molecules is excellent.

It provides a wide variety of bulk drugs and exports sophisticated bulk

drugs.


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LEGAL & FINANCIAL FRAMEWORK:

India has a 60 year old democracy and hence has a solid legal framework

and strong financial markets. There is already an established international

industry and business community.

INFORMATION & TECHNOLOGY:

It has a good network of world-classes educational institutions and

established strengths in Information Technology.

GLOBALIZATION:

The country is committed to a free market economy and globalization.

Above all, it has a 70 million middle class market, which is continuously

growing.

CURRENT SCENARIO:

THE GROWTH SCENARIO:

Indias US$ 4.1 billion pharmaceutical industry is growing at the rate of 14

percent per ye ar. It is one of the largest and most advanced among the

developing countries. Over 20,000 registered pharmaceutical manufactures exist

in the country. The domestic pharmaceutical industry output is expected to

exceed Rs.260 billion in the financial year 2002, which accounts formerely 1.3%

of the global pharmaceutical sector. Of this, bulk drugs will account for Rs. 54

bn (21%) and formulations, the remaining Rs 210 bn (79%).

EXECUTIVE SUMMARY

This report has been made keeping in mind the Indian Pharmaceutical industry, its growth rate

as compared to the global Pharmaceutical Industry. India's US$ 3.1 billion pharmaceutical

industry is growing at the rate of 14 percent per year. It is one of the largest and most advanced

among the developing countries. The Indian Pharmaceutical sector is highly fragmented with

more than 20,000 registered units. It has expanded drastically in the last two decades. The

leading 250 pharmaceutical companies control 70% of the market with market leader

holding nearly 7% of the market share. It is an extremely fragmented market with

severe price competition and government price control. Then, we look at the market

and growth scenario of Pharmaceutical companies in India which brings us to

research on MATRIX PHARMALABS.


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FUTURE PROSPECTS:

The Indian Pharmaceuticals market is expected to reach US$55 billion in 2020 from US$12.6

billion in 2009. This was started in a report title IndianPharma 2020: Propelling access and

acceptance, realizing truepotentialby McKinsey & Company. In the same report, it was also

mentioned that in an aggressive growth scenario, the pharma market has the further potential to

reach US$70 billion by 2020.

Due to increase in the population of high income group, there is very likelihood that they will

open a potential US$ 8 billion market for multinational companies selling cost drugs by 2015.

This was estimated in a report by Emst & young. The domestic pharma market is estimated to

touch US$ 20 billion by 2015. The health care market in India to reach US$ 31.59 billion by

2020.

The sale of all types of pharmaceutical drugs and medicines in the country stands at US$ 9.61

billion, which is expected to reach around US$ 19.22 billion by 2012. Thus India would really

become a lucrative destination for clinical trials for global giants.

There was another report by RNCOS titled BoomingPharma Sector in Indiain which it was

projected that the pharmaceutical formulations industry is expected to prosper in the same

manner as the pharmaceutical industry. The domestic formulations market will grow at an

annual rate of around 17% in 2010 and 2011, owing to increase middle class population and

rapid urbanization.

Steps to strengthen the Industry:

Indian companies need to attend the right product- mix for sustained future growth.

Core competencies will play an important role in determining the future of many Indian

Pharmaceutical companies in the post product-patents regime after 2005.

The companies in an effort to consolidate their position will have to increasingly look at

merger and acquisition options of either companies or products.

Research and development has always taken the back seat amongst Indian

Pharmaceutical companies.

The Indian Pharmaceutical Industry also needs to take advantage of the recent advance

in biotechnology and information technology.


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ABOUT THE COMPANY:

Dr. Reddys laboratories was founded by Dr. Anji Reddy, entrepreneur-scientist, in 1984 the

DNA of the company; is drawn from its founder and his vision to establish Indias first

discovery led global pharmaceutical company .in, fact, it is this spirit of entrepreneurship that

has shaped the company to become what it is today. The company is focused on creating and

delivering innovative and quality products to help people lead healthier lives.

Dr.Reddys is the research based company with vertically integrated operations. The company

develops, manufactures and markets a wide range of pharmaceutical products India and

overseas. Dr. Reddys produces finished dosage forms, active pharmaceutical ingredients,

diagnostic, kits, critical are and biotechnology products. The basic research program of Dr.

Reddys focused on cancer diabetes, bacterial infections and pain.

Since its inception in 1984, Dr. Reddys has chosen to walk the path of discovery and

innovation in health sciences R eddys has been a quests to sustain and improve the quality of

life, and they; heaves had nearly two decades of creating safe pharmaceutical Solutions with

the ultimate purpose of making the world a heather place. Dr. Reddys create and deliver

innovative pharmaceutical health care solutions that people enjoy longer, healthier and more

productive lives. Reddys generic formulations have also become very popular in quality-

conscious regulated markets such as the US and Europe. We are all set to spread pure wings

further and touch more lives across the globe

In 1973, after gaining six years of experience in the manufacturing and implementation of new

technologies in bulk drugs from public sector company IDPL, Hyderabad. Dr Reddys decided

to start up basic drugs unit at that time there were few other players in the private sector at that

end of the pharmaceutical value chain.

In 1975, Dr. Reddys started the construction of uniloids of which he was the founder-managing director it was here that they made a move that was to become the hallmark of the

group in the years to come.

This move was first to construct and stat R&D laboratory ever before commencing the

construction of the plant. Based on the work done in these laboratories he constructed a plant in

1976 to manufacture, for the first time in India, drug called metrodinazole for the treatment of

amoebic dysentery the drug became a hit.


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In 1981, as managing director of standard organics Ltd; Dr. Reddys aim was to develop and

manufacture a wide spectrum of bulk drugs to enable the pharmaceutical industry to launch

their formulations. Unfettered. There were only a couple ofpharmaceutical companys at that

time with the capacity to develop newer drugs bit they would not sell the bulk to other

formulators. Here, Dr. Reddys played a major role in pioneering the technology and

production of sulphamethonazole an anti bacterial in India. Another dream was to do it on his

own, because that was the time that his second experiment with partnership was also

crumbling. He realizes his dream shortly thereafter, then the established Dr. Reddys

laboratories in 1984. The process and production of methyldopa was the ultimate challenge.

The company has several distinctions to its credit. Being the first pharmaceutical company

from Asia Pacific (outside Japan) to be listed on the New York Stock Exchange (on April 11,

2001) is only one among then. And as always, Dr. Reddys chose to do it in the most difficult

of circumstances against widespread skepticism. Dr.Reddys came up trumps not only having

its stock oversubscribed but also becoming the best performing IPO that year.

Dr. Anji Reddys is well known for his passion for research and drug discovery. Dr Reddys

started its drug discovery programmed in 1993 and within three years it achieved its first break

through by out licensing an antidiabetes molecule to Novo Nor disk in March 1997/ With

this very small but significant step, the Indian industry went through a paradigm shift in its

image from being known as just copycats to innovators! Through its success, Dr. Reddys

pioneered drug discovery in India. There are several such inflections points in the companys

evolution from a bulk drug (API) manufacturer into a vertically integrated global

pharmaceutical company today.

Today , the company manufactures and markets API(Bulk Actives), Finished Dosages and

Biologics in over 100 countries worldwide, in addition to having a very promising Drug

Discovery Pipeline. When Dr. Reddys started its first big move in 1986 from manufacturingand marketing bulk actives to the domestic (Indian) market to Manufacturing and exporting

difficult-to-manufacture bulk votes such as Methyldopa to highly regulated overseas markets, it

had to not only overcome regulatory and legal hurdles but also battle deeply entrenched mind-

set issues of Indian Pharma being seen as producers of cheap and therefore low quality

pharmaceuticals.

Today, the Indian pharma industry, in stark contrast, is known globally for its proven high

quality-low cost advantage in delivering sage effective pharmaceuticals. This transition, a

tough and often-perilous one, was made possible thanks to the pioneering efforts of companies

such as Dr. Reddys Laboratories.


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Dr. Reddys is a global, vertically integrated pharmaceutical company with a presence across

the value chain, producing and delivering safe, innovative, and high quality finished dosage

forms, active pharmaceutical ingredients and biological products. Our products are marketed

across the globe, with an emphasis on North America, Europe, India, Russia and other

emerging markets. We conduct NCE drug discovery research in the areas of metabolic

disorders and cardiovascular indications at our research facilities in Atlanta (USA) and

Hyderabad (India). Through our Custom Pharmaceutical Services business unit, we provide

drug substance and drug product development and manufacturing services on a proprietary

basis.

Today, Dr. Reddys continues its journey. Leveraging on its Low Cost, High Intellect

advantage. Foraying into new markets and new businesses. Taking on new challenges and

groaning stronger and more capable. Each failure and each success renewing the sense of

purpose and helping the company evolve with over 950 scientists working across the globe,

around the clock, the company continues its relentless march forward to discover and deliver a

breakthrough medicine to address an unmet medical need and make a difference to peoples

lives worldwide. And when it does that, it would only be the beginning and yet it would be the

most important step. As Lao Tzu wrote a long time ago, Even 1000mile journey starts with a

single step.

DR.REDDYS LTD IN INDIA:

Dr.Rdeddys originally launched in 1984 producing generic medications. In 1986, Reddys

started operations on branded formulations. Within a year Reddys had launched Norilet, the

companys first recognized brand in India. Soon, Reddys obtained another success with Omez,

its branded omeprozoleulcer and reflux oesophagitis medication launched at half the price

of other brands on the Indian market at that time.

Within a year, Reddys became the first Indian company to export the achieve ingredients for

pharmaceuticals to Europe. In 1987, Reddys started to transform itself from a supplier of

pharmaceutical ingredients to other manufactures into a manufacture of pharmaceutical

products.

Dr.Reddys began as a supplier to Indian drug manufactures, but it soon started exporting to

other less-regulated markets that had the advantage of not having to spend time and money on a

manufacturing plant that would gain approval from a drug licensing body such as the U.S. Food

and Drug Administration. This allowed their movement into regulated markets such as the US

and Europe.


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OBJECTIVES:

To creating a work environment that promotes safety, people training and development

and performance orientation in line with Dr Reddys values and policies.

To Improvement in supply and availability of utilities and time bound repair of m/c andequipments (along with the relevant records as per site objectives).

Ensure that the equipment and related systems (both old and new) are (re)qualified /

(re)validated as per schedule.

Reduce utilities consumption in line with the site objectives. To identify and implement

energy conservation measures.

To ensure that all the drawings and technical specifications of the equipment and

system in his/her area is updated.

To ensure clean room performance (checks, calibration, qualification and maintenance,

along with documentation, of filters and other related equipments) as per SOP.

To reuse and recycle equipments, etc. where ever possible.

Trouble shooting with an objective of finding permanent solution.

To ensure the facility is as per site objectives at all times.

To ensure the good upkeep of the department.

Liaisoning (with peers and outside agencies) to meet business objectives.


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COMPANY VISION

Our vision is to become a discovery-led global pharmaceutical company.

We will achieve this vision by building:

A workplace that will attract, energise and help retain the finest talent available. An

organizational culture that is relentlessly focused on the speedy translation of scientific

discoveries into innovative products to make a significant difference in peoples lives.

COMPANY MISSION:

To be the first Indian pharmaceutical company that successfully takes its products from

discovery to commercial launch globally.

We are on a tough mission and energies can easily dissipate unless there is direction and

dedication.

AWARDS:

The Dr. Reddys ltd has been a regular recipient of the awards for excellence in Pharma sector,

best employees and most respected company.

The Saumen Chakroborty- CFO of awarded to Dr. Reddys lab the Best Performance Award

sustained for CFO in the Pharma Sector for 2007 development of overseas business.

D .Reddys lab also received the award in 2004 for the Most Respected Company award.

It also received the award in 2004 for the Best Employers in India.

For development of indigenous know-how, continued support is also necessary and a detailed

write up on R&D facilities is enclosed.


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INSIGHT INTO VARIOUS DEPARTMENTS:

RESEARCH AND DEVELOPMENT:

The research and development division, established in the late 1980s, is central to the

active pharmaceutical ingredients business. It contributes significantly to our business by

creating intellectual property, providing research to reduce the cost of production of the

products and playing an active role in the selection and development of new products.

The analytical research group supports the development activity by carrying out impurity

profiling, structure elucidation and stability studies.

MANUFACTURING UNITS:

Cheminor drugs Ltd. Merged in to Dr. Reddys Labs in the year 2000 -01

restructured as Strategic Business Units.

Bulk

Branded formulation

Generics

R&D emerging business

Corporate center


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Units: Strategic Business Units Bulk has 6units.

3 units in Bollarum

1 unit in Jeedimetla.

1 unit in Miryalaguda

1unit in PydiBhimavaram

QUALITY POLICY:

Dr.Reddys is committed to provide customers products meeting or exceeding

exceptions consistently in terms of specifications, delivery, technical support,

regularity compliance & competitive.

Customer Focus:

We are committed to delight customers by providing products and services that

exceed expectations consistently in terms of quality, speed to market, delivery and

competitiveness

Execution Excellence:

We will constantly improve systems, technologies, infrastructure, regulatory compliance and

technical support.

Competency Building:

We will ensure high level of competency by attracting and retaining talented personnel in all

areas through continual education and development.

Beneficial Partnerships:

We will develop and maintain mutually beneficial relationships with all business associates

and provide lasting value to all stakeholders. Constantly improve the procedure,

technologies & infrastructure to continuously better the quality of products produced. Ensure

optimum training to all personnel accountable for quality related activities. Maintain

mutually beneficial relationship with vendors, enrich the quality of life of employees &

provide lasting value of shareholder.


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SOCIAL INITIATIVES:

We at Dr. Reddys take pride in the companys mission to help people lead

healthier lives. This objective is achieved by increasing access and affordability of

medicines through the companys generics, API, and branded generics products, and

by addressing unmet medical needs by innovation through its Specialty and NCE

businesses.

We see Social Initiatives as an integral component of Corporate Social Responsibility.

Our investments in the community have gone beyond the adhoc disbursement of

funds, to planned programs in capability building. We do this by supporting the

following organizations:

Dr. Reddys Foundation

The Naandi Foundation

Dr. Reddys Foundation For Health Education (DRFHE)

The Centre for Social Initiative & Management (CSIM)

Our Social Initiatives do not involve just the community, but employees as well by including

employees in our definition of Social Initiatives, the company ensures that the initiators also

figure among the beneficiaries.


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ORGANIZATION STRUCTURE

Illustration No. II.1 Organization Structure of Dr. Reddys lab

Managing

Director

Manager

Finance

Manager

Human

Resources

Manager

Marketing &

Distribution

Manager

Contracts

Division

Manager

Explosives

General

Manager

Manager

Production


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PERFORMANCE OF THE COMPANY:

Dr. Reddys laboratories (DRL) reported higher-than-expected 4qfy2012 top-line

performance, while its bottom line came in below expectations.

The companys net sales increased by 31.8% yoy, led by 29.9% yoy and 26.8% yoy growth

across the global generics and proprietary products businesses, respectively. This led to OPM

expansion and net profit growth during the period. Management has reinforced its FY2013

guidance of us$2.7bn, with RoCE expected to come in at 25%. We recommend accumulate

on the stock.

Results much above expectations: DRL reported net sales of Rs.2,658 cr for 4QFY2012,

registering 31.8% yoy growth, which was higher than our estimate of Rs.2,272cr. The U.S.

and row were the key growth drivers for the company, registering strong growth of 47.5%

yoy and 32.3% yoy, respectively. The domestic market reported single-digit growth of 16.7%

yoy. The companys EBIT margin expanded by 235bp yoy to 18.9%, resulting in adjusted net

profit growing by 28.9% yoy to Rs.431cr during the quarter.

Outlook and valuation: DRL has reinforced its earlier revenue guidance of US$2.7bn by

FY2013E with RoCE of 25%. We expect net sales to report a 9.8% CAGR to rs.11,662cr and

adjusted EPS to record a 2.3% CAGR to rs.92.9 over FY2012-14E. We maintain our

Accumulate Recommendation on the stock with a target prize of Rs.1,859.


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BOARD OF DIRECTORS:

Drs Anji Reddy, Chairman

GV Prasad , Vice Chairman & CEO

K. Satish Reddy, COO & MD

Abhijit Mukharjee, President Global Genetics

Dr. Cartikeya Reddy, Senior Vice-President & Head Biologics

KB. Shankara Rao, Exicutive Vice-President IPDO

Vilas bholye, HeadFormulations Manufacturing

Dr. Raghav Chari, Senior Vice-President-Proprietary Products

Prabir Jha, Senior Vice-President Global Chief HR.

Amit Patel, Senior Vice-President & Head-NA Genetics

Saumen Chakraborty, President-Corporate

Umang Vohara, Chief Financial Officer

VS Vasudevan, Head of Europe Operations.


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COMPANY VALUES:

Our business practices are guided by highest ethical standards of truth integrity and

transparency. To strive for excellence in everything they think, say and so. The values that

guide the thoughts and actions are:

Quality:

Reddys are dedicated to achieving the highest levels of quality in everything we do to

delight customers, internal & external, every time.

Respect for the individual:

We uphold the self-esteem and dignity of each other by creating an open culture

conducive for expression of views and ideas irrespective of hierarchy.

Innovation & continuous learning:

We create an environment of innovation and learning that fosters, in each one of us, a

desire to excel and willingness to experiment.

Collaboration & Teamwork:

Dr.Reddys seek opportunities to build relationships and leverage knowledge,

expertise and resources to create greater value across functions, businesses and

locations.

Harmony & Social Responsibility:

Dr.Reddys take utmost care to protect our natural environment and serve the

communities in which they live and work.


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SWOT ANALYSIS OF DR.REDDYS LAB

STRENGTH:

Strong products portfolio.

Low cost based.

Six-new chemical entities.

Wide range of anti-cancer drugs developed.

Contribute to companys high profit margin of around 34% of sale.

Manufacturing & market over 250 medicines targeting a wide range of therapies.

Expertise in developing innovative product formulations.

Markets pharmaceutical products in 115 countries. Joint ventures in China & South Africa.

WEAKNESSES

High amount of revenues from overseas.

Generic drugs smallest focus.

Lack of patent legislation in India harms sales of its products.

Smallest portion of revenues from generic at around 20%.


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OPPORTUNITIES:

Take a drug then way to market.

Domestic generic drugs market.

In another 4-6 years many product patent obtained after the 2004 legislation will

go off providing an opportunity to the company increase its domestic footprints in

Generic

.Buy back of the integrated drug development company from ICICI venture &

Citigroup.

THREATS:

Need to gain FDA approval for all sources & products.

Heightened concerns about profitability of German generics business of Beta

pharm.

Revenue running into billions which dwarfs Reddys annual turnover litigation

charges.

Products have to pass strict FDA trails before going to market, which can be

costly and time consuming.


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CHAPTER - 3

REVIEW OF LITERATURE


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CAPITAL BUDGETING

Capital expenditure management or capital budgeting is concerned with planning and control

of capital expenditure. Capital budgeting is defined as the acquisition of durable productive

facilities in the expectations of future gains. To win the competitive edge, every organization

is much construction on the financial aspect of development. It involves the current outlay of

cash in return for an anticipated flow of future benefits and these benefits are available in the

long run. Therefore, capital budgeting refers to a long-range investment programmes and is

translated into annual budget outlay and may relate to National Five Year Plans.

Capital budgeting is a crucial financial decision of a firm. It relates to the selection of an assetor investment proposal for the lifetime of the project. Capital budgeting is the allocation of

available resources of the organization to the various investment proposals, as the demand on

resources is almost always higher than the availability of resources.

Capital budgeting decisions are related to allocation of investible funds to different long-term

assets. They have long-term implications and affect the future growth and profitability of the

firm. For example: the decision to acquire special equipment may require a large immediate

outlay of funds. It also commits the company to the maintenance and operations of the

equipment for a long period of time.

Organization is frequently faced with capital budgeting decision. Any decisions that require

the use of resources or course of action whose benefits are likely to be available in future

over the lifetime of the project. Capital budgeting is more or less a continuous process in any

growing concern. Some of the decisions may directly affect the profit of the firms whereas

some other decisions may directly affect the profit by influencing the operating costs.

However, in all cases, the decisions have a long-term impact on the performance of the

organization.

Given the importance of capital budgeting, the decision regarding investment, management

faces the challenging task of allocating the limited available resources in a matter that would

maximize the profits or the objectives of the organization.


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Financial management, in the modern sense of the term can be broken down in to four

decisions as function of finance, they are:-

The investment or long-term assetmix decision.

Financing or capitalmix decision.

Dividend or profit allocation.

Liquidity or short-term assetmix decision.

DEFINITION:

Char les THorngreenhas defined as Capital budgeting is the long term planning for making

and financing proposed capital outlays.

In other words of Lynch,Capital budgeting is concerned with planning and development of

available capital for the purpose of maximization the long-term profitability of the concern.

MEANING:

Capital budgeting is the process of making investment decision and capital expenditure. It

also involves a non-flexible, long-term commitment of funds thus capital expenditure

decisions are also called as long-term Investment decisions.

FEATURES:

It involves exchange of current funds for the benefits to be achieved in future.

Future benefits are expected to be realized over a series of years.

They generally involve huge funds.

They are irreversible decisions.

They have long term and significant effect of probability of the concern.

There is relatively high degree of risk.


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OBJECTIVES:

Establish cost guidelines and benchmarks to assist analysts in budget development.

Clarify our understanding of funding constraints and conditions to make it easier to

correctly align project types with funding sources.

By taking a more comprehensive approach to the budget development and

implementation cycle, eliminate low-value tasks and help all participants focus on the

most important issues.

Improve tools for the budget processes to reduce the burden of administrative tasks

and increase time available for analysis and decision-making.

Ensure better connections between the operating and capital budgets

Improve the allotment and monitoring processes to reduce time spent on non-value

added tasks.

Improve the guidance available for everyone involved in the capital budget process.

Make better use of information about facility needs and conditions for budget

development and monitoring.

Streamline the budget bill process.


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IMPORTANCE:

There are the several factors that make capital budgeting decisions among the critical

decisions to be taken by the management. The importance of capital budgeting can be

understood from the following aspects of capital budgeting decisions.

By taking capital budgeting decision, a finance manager makes a commitment into

future. He is also committing to the future needs for funds of that project.

The capital budgeting decisions generally involve large commitment of funds. As a

result, substantial portion of capital funds is blocked. Thus, relatively, more

attention is required for capital budgeting decisions.

Most of the capital budgeting decisions are irreversible decisions. Once taken, the

firm may not be in a position to revert back unless it is ready to absorb heavy losses

which may result due to abandoning a project midway.

Capital budgeting decisions affect the capacity and strength of a firm to face

competition. A firm may loose competitiveness if the decision to modernize is

delayed.

A timely decision to take over a minor competitor may ultimately result even in the

monopolistic position of the firm. These decisions affect the future position of the

firm to a considerable extent.

DIFFICULTIES:

Capital budgeting decisions are not easy to take. There are number of factors responsible for

this. The problems in capital budgeting decisions may be as follows:

Capital budgeting decisions involve long-term commitments. However, there is a

lot of uncertainty in the long-term. Therefore, an element of risk is involved. The

uncertainty may be with reference to cost of the project, future expected returns,

future competition, legal provisions, political situation etc.

The cost of benefits of a decision may occur at different time period. They are not

logically comparable because of the time value of money.

The financial manager may face difficulties in measuring the cost and benefits of

projects in quantitative terms. It is very difficult in the extent of impact as the sales

of other products may also influence by these factors other than the new products.


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ASSUMPTIONS:

Capital budgeting decisions process is a multi-faceted and analytical process. A number of

assumptions are required to be made and evaluated in the financial aspects.

The capital budgeting decisions are taken with a primary motive of increasing the

profit of the firm. No other motive influences the decision of the financial

manager.

It is very difficult to estimate the cost and benefits (proposal beyond 2-3 years in

future) which are reasonably accurate and certain.

It assumes that a proposal will be accepted or rejected on the strength of its merits

alone. The proposal will not be considered in combination with other proposals to

consider the maximum utilization of available funds.

INVESTMENT DECISION:

The major second decision of the firm is Financing Decision. It is mainly

concerned with mobilization of funds. Here, the financial manager is concerned with

determining the best financing mix or capital structure for his firm. The management will

decide how much funds should be raised from outside public and financial institutions.

Investment decisions are expected to bring in additional revenue there by raising the size

of firms total revenue. These decisionsinvolved in acquisition of fixed assets.

SOURCES OF FINANCE:

Equity Share Capital

Preference Share Capital

Debenture Capital

Long term Loans from Financial Institutions.

Public Deposits.

Reserves and Surplus


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DIVIDEND DECISION:

Dividend refers to that portion of a firms net earnings, which are paid out to the

shareholders. Dividend decision had got two alternatives, one is declaring immediately and

issuing in the form of cash/bonus shares to the shareholders, or retailing them with the firm

for further investment proposals. Dividend decision will have impact on the value of the firm

and its objective is to maximize the shareholders wealth.


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CAPITAL BUDGETING PROCESS

Capital budgeting is process of selecting best long-term investment project. Capital budgeting

is long-term planning for making and financing proposed capital outlaying.

Steps for capital budgeting process as follows:

Identification involved in capital budgeting proposals.

Evaluation of various proposals

Final approval and planning the capital expenditure

Implementing the proposal

Performance review

Screening the proposal

Fixing the priorities


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Types of Capital Budgeting Decisions

Capital budgeting refers to the total process of generating, evaluating, selecting and following

up on capital expenditure alternatives. The firm allocates or budgets financial resources to

new Investment proposals. Basically, the firm may be confronted with three types of capital

budgeting decisions:

Accept-Reject Decision.

Mutually Exclusive Project Decision.

Capital Rationing Decision.

Accept-Reject Decision:

This is a fundamental decision in capital budgeting. If the project is accepted, the firm would

invest in it; if the proposal is rejected, the firm does not invest in it. By applying this

criterion, all independent projects are accepted. Independent projects are the projects that do

not compete with one another in such a way that the acceptance of one precludes the

possibility of acceptance of another.

Mutually Exclusive Project Decision:

Mutually Exclusive Projects are those which compete with other projects in such a way that

the acceptance of one will exclude the acceptance of the other projects. The alternatives are

mutually exclusive and only one may be chosen. Thus, mutually exclusive projects acquire

significance when more than one proposal is acceptable under the accept-reject decision.

Capital Rationing Decision:

Capital rationing refers to a situation in which a firm has more acceptable investments than it

can finance. It is concerned with the selection of a group of Investment proposals out of many

investment proposals acceptable under the accept-reject decision. The projects can be ranked

on the basis of a pre-determined criterion such as the rate of return. The projects are ranked in

descending order of the rate of return.


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SELECTION OF PROJECTS

Experience shows that many projects are recommended for inclusion in the capital budget

that despite of the apparent desirability, may not be necessary for the firm or many not

produce additional earnings commensurate with the capital involved. They keep capital

outlays within regional limits; capital budgets control producers should be designed to ensure

that more desirable project get the priority over others. The proposal submitted by the

operating divisions or departments for inclusions or the capital budget can be classified under

the following categories:

Urgently essential to satisfactory operations.

Replacement resulting from wear and tear or obsolescence.

Desirable on an earnings basis and

Desirable from the stand-point of logical expansion and development.

REVIEW:

The procedures for review or an approval of capital proposals vary from company to

company. Minor projects may be approved at low management levels. Major projects on the

other hand, must pass the scrutiny of top management. As the amount involved increases, so

does the level of authority required for approval.

Some companies require merely a statement of justification giving the essential facts about

the project. Others, particularly the better managed ones, have evolved standard forms which

should be filled for each proposed expenditure about a certain minimum level. These forms,

designed to describe the proposal and this purpose, show the estimated cost of the proposed

project, reflect the projects influence on operating costs and profits, provide information on

any equipment to be replaced and serve as the medium for obtaining necessary approval andsanctions.

Date of request

Project identification number

Description of the project

Purpose of and risks of the project

Estimated total cost

Estimated starting and conclusion dates


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Estimates of the amounts and timing of expenditures

Estimated cost savings or other economic or financial justifications and

Estimations of the amount and timing of income from the project approvals.

It is necessary to emphasize the importance of the three major parts of the appropriation

requests:

To estimate the amount of investments required

The timing estimates

The estimates of the income from the project.

PRINCIPALS OF CAPITAL INVESTMENT:

Capital budgeting involves the generation of investment proposals; the estimate of cash flows

for the proposals, the evaluation of cash flows; the selection of projects based upon an

acceptance criterion; and finally, the continual revaluation of investment projects after their

acceptance.

Depending upon the firm involved investment proposals can emanate from a variety of

sources. For purposes of analysis, projects may be classified in to one of five categories.

New products or expansion of existing products

Replacement of equipment or buildings

Research and development

Exploration

Others.

Most firms screen proposals at multiple levels of authority. For a proposal originating in the

production area, the hierarchy of authority might run from section chiefs to

Plant managers to

The vice-president for operations to

A capital-expenditures committee under the financial manager to

The president to

The board of directors


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The best procedure will depend upon circumstance where projects are approved at multiple

levels, it is very important that the same acceptance criterion be applied objectively and

consistently throughout the organization. Otherwise, capital is likely to be misallocated in the

sense that one division might accept a project that another would reject.

COMPONENTS OF INVESTMENT ANALYSIS

The capital budgeting process requires an estimate of future events to be expressed in a

schedule of cash flows. At any given time, a company may be having a number of alternative

ways, termed as project to invest in funds and the purpose of a capital budgeting procedure to

obtain an indication of a value each might contribute to the company. Before applying any

method to evaluate the relative desirable of a project, it is necessary to analyze the

components effecting the projection of cash flows, both in and out, related to the projects,

together with the time dimension of each flow. The basic components of investment analysis

are:

Amount of net capital investment.

Operating cash flows.

Choice of horizon.

OPERATING CASH FLOWS:

Operating cash flows are not identified with profits or income. It is essential to recognize

difficulties that arise in applying a cash flow analysis to investment proposals. A charge in

income can occur without any corresponding change in cash flow. The cash flow procedure

avoids difficult problems underlying the measurement of corporate income, which usually

accompany the accrued method of accounting.

ABSOLUTE AND RELATIVE CASH FLOWS:

A distinction should be made between absolute and relative cash flows. When cash flows are

compared with zero cash flows, they are known as absolute cash flows. The cash flows of one

project can be compared directly with that of in other project or difference in cash flows of

two projects can be determined. If this difference itself is positive in a particular period, it can

from another. Such cash flows are known as relative cash flows.


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CASH FLOWS AND UNCERTAINTY:

Each computation of cash flows is based on certain assumptions on the level of business

activity, nature of production, future availability of improved equipment, cost of factors of

production, future demand and the like.

The growing use of computers applications now enables the financial analyst to take analysis

of various levels of possible cash flows, return on investment and other results of proposed

outlay and obtain an estimate of the odds of each potential outcome. Under the probability

approach, estimates of variety of factors such as market size, selling prices, market growth

rate, share of the market, investment cost, can be varied.

IDENTIFYING RELEVANT CASH FLOWS:

CASH FLOW VS ACCOUNTING PROFIT:

Capital budgeting is concerned with investment decisions, which yield a return over a period

of time in future. The foremost requirements to evaluate any capital investment proposal are

to estimate the future benefits accruing from the investment proposals. Theoretically, two

alternatives criteria are available to qualify the benefits:

Accounting profit.

Cash flows.

The difference in these measures of future profitability is primarily due to the presence of

certain non-cash expenditure in the profit and loss a/c. cash flows are theoretically better

measures of the net economic benefits or costs associated with a proposed project.

INCREMENT CASH FLOW:

The second aspect of the data required for budgeting relates to the basis on which the relevant

cash out flows associated with proposed capital expenditure are to be estimated. The widely

prevalent practice is to adopt increment analysis. Only difference is due to the decision at

hand.


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TECHNIQUES OF CAPITAL BUDGETING:

Capital budgeting decision process involves estimation of cost and benefits of a proposal,

estimation of required rate of return, and evaluation of different proposals in order to select

one. These cost and benefits are expressed in terms of cash flows arising out of a proposal.

Once the proposal completed we can discussed the various techniques to arrive at the optimal

investment decision.

The method of evaluation of capital expenditure proposal can be classified in to two broad

categories:

Traditional or Non-Discounting Techniques.

Discounted Cash Flows or Time Adjusted Techniques.

TRADITIONAL OR NON-DISCOUNTING TECHNIQUES:

Pay Back Period Method.

Average Rate of Return Method or Accounting Method (ARR).

DISCOUNTING CASH FLOWS OR TIME ADJUSTED TECHNIQUES:

Net Present Value Method (NPV).

Internal Rate of Return Method (IRR).

Profitability Index or benefit cost ration Method (PI).


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TRADITIONAL OR NON-DISCOUNTING TECHNIQUES:

PAYBACK PERIOD:

The Payback Period is defined as the number of years required for the proposals

cumulative cash inflows to be equal to its cash outflows. It is also the length of the time

required to recover the initial cost of the project. The payback period therefore, can be looked

upon as the length of time required for a proposal to break even on its net investment.

If the calculated PBP is less than the standard, project is accepted and vice versa.

If the cash-flows are even

PBP= initial investment/cash-flows after taxes

When project cash flows are not equal and vary from year to year.

PBP = base year + (amount to be recovered/next year cash-flows)

Payback period is calculated.

DISCOUNTED PAYBACK PERIOD:

This is developed due to the limitations of the PBP method that it ignores the time

value of money. Hence, an improvement is made where the present values of all inflows are

cumulated in order of time. The time at which the cumulated present value of cash inflows

equals the present value of cash outflows is known as discounted PBP. The project, which

gives a shorter discounted PBP, is accepted.

Accept or reject Criterion:

The payback period method can be used as a decision criterion to accept or rejectinvestment proposals. If a single investment is being considered, if the annual payback period

is less than the predetermined payback period the project will be accepted, if not it would be

rejected.

When the mutually exclusive projects consideration they may be ranked according to the

length of the payback period. The project with shortest payback may be assigned.


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Merits:

It is the best method in case of evaluation of single project.

It is easy to calculate and simple to understand.

It is based on the cash flow analysis.

Demerits:

It completely ignores all cash flows after the payback period.

It completely ignores the time value of money.

ACCOUNTING RATE OF RETURN (ARR):

Average rate of return is also known as accounting rate of return method. It is based

on accounting information rather than cash flows. ARR is a technique that helps us in

knowing the particular project, from which decision can be made to accept or reject the

investment proposal.

According to ARR as an accept / reject criterion, the actual ARR would compared

with the predetermined or a minimum required rate of return or cut off rate. A project can be

accepted if the actual ARR is higher than the minimum desire ARR, otherwise it is liable toreject.

ARR depends upon profit after depreciation and tax (PAT), ARR neglects the scrap

value. The time value of money is not taken into consideration.

ARR = x 100

Average Investment=

Net additional working capital + Salvage value + (Original investmentSalvage Value)

Average Annual Profit after Tax=

Total cash-flows after taxes / life of the asset


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Merits:

It is very simple to understand and easy to operate.

The entire stream is used to calculate the average rate of return.

As this method is based upon accounting concept of profits, it can be readily

calculated from the financial data.

Demerits:

ARR also ignores the time value of money as the profits earned at different points of

time are given equal weight by averaging the profits.

It does not take into consideration the cash flows which are more oimportant than the

accounting profits.

This method cannot be applied to a situation where investment in a project is to be

made in parts.

DISCOUNTING CASH FLOWS OR TIME ADJUSTED TECHNIQUES:

The distinguishing characteristic of the discounted cash flow capital budgeting techniques is

that they have taken into consideration the time value of money while evaluating the cost and

benefits of the project.

NET PRESENT VALUE (NPV) METHOD:

NPV may be defined as the summation of the present values of the cash proceeds in

each year minus the summation of the present values of the net cash outflows in each year.

The NPV of a project is the sum of the present values of all the cash flows positive as well as

negative that are expected to occur over the life of the projects.

The general formula of NPV is:-

NPV = PRESENT VALUE OF CASH INFLOWSTOTAL INVESTMENT


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The steps to be followed for adopting the NPV methods:

Determine an appropriate rate of interest that should be selected as a minimum

required rate of return. This rate should be minimum required rate of return below

which the investor considers that does pay him the invested amount.

Compute the present value of total investment outlay, if the total investment is to be

made in the initial year, the present value shall be the same the cost of the investment.

Compute the present value of total investment proceeds i.e. cash inflows at the above

determined discounted rate.

Calculate the NPV of each project by subtracting the present values of outflows for

each project.

The present value of rupee 1 is due in any number of years can be found by using the

following formula.

PV = (1+r) t

Where PV = present value

R = rate of interest

T = number of years

.Accept or reject Criterion:

If NPV > ZERO, ACCEPT

If NPV < ZERO, REJECT

Merits:

It recognizes the time value of money.

It is sound method of appraisal as it considers the total benefits arising out of the

proposal over its lifetime.

Changing discount rate can be built into the NPV calculation by altering the

denominators. This rate normally changes because longer the time span, lower the

value of money and higher the discount rate.

This method is very useful for selection of normally exclusive projects.


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Demerits:

The present value method involves calculation of required rate of return to discount

cash flows, which present serious problems.

It is an absolute measure.

This method may not give satisfactory results in case of projects having different

effective lives.

INTERNAL RATE OF RETURN (IRR) METHOD:

The internal rate of return (IRR) of a project is the discounted rate, which makes its

NPV equal to zero. Put differently, it is the discounted rate, which equates the present value

of future cash flows with initial investments. It is the value or r in the following equation.

\Where; Ct = Cash flows at the end of the year.

R = Internal rate of return (IRR).

T = life of the project.

Following steps are required for the calculation of IRR

1.

Calculate the cash flow after tax

2. Calculation of Present value factor

NPV =

3. Look at the factor in the present value annuity table in the year column until you

arrive at figure until you closest to the closed PVF.

4.

Note the corresponding percentage.

5. Calculate NPV at that percentage.

6. If NPV is positive take a rank higher and if NPV is negative take regret lower and

once again calculate NPV

n

Investment=ct

T=1(1+R)


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7.

Continue Step 5 until we arrive at low rate one giving positive NPV and pother giving

negative NPV.

8.

Actual IRR can be calculated by using the following formula.

IRR = LR + (NPV at LR / (NPV at LRNPV at HR)) x (HR - LR)

Where; R = interest rate

LR = lower rate

HR = higher rate

Accept or reject Criterion:

ACCEPT: If the IRR is greater than the cost of Capital.

REJECT: If the IRR is less than the cost of capital.

Merits:

It recognizes the time value of money.

It considers all cash flow occurring over the entire life of the projects to calculate its

return.

It is consistent with the shareholders wealth maximization objective.

Demerits:

It gives misleading and inconsistent results when the NPV of a project does not

decline with discount rates.

It also fails to indicate a correct choice between mutually exclusive projects under

certain situations.

PROFITABILITY INDEX METHOD :

It is the ratio of the present value of the cash inflows at the required rate of return to the initial

cash outflow of the investment. Using the profitability index PI or benefits cost ratio (BCR) a

project will qualify often acceptance if its PI exceeds one. The NPV will be positive when it

is greater than one and it is negative when PI is less than one. Thus, NPV & PI approaches

give the same results regarding the investment proposal. The selection of project with the PI

method can also be done on the basis of ranging. PI depends upon the cash inflows after

depreciation and after tax. It makes into consideration the scrap value, The formula to

calculate PI or BCR is as follows.


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PI =

Merits:

It gives due consideration to the time value of money.

Since the present value of cash inflows is divided by initial cash outflows, it is a

relative measure of the projects profitability.

RISK AND UNCERTAINITY IN CAPITAL BUDGETING:

Capital budgeting entails decisions to commit present funds in long term investment in

anticipation of future returns. The amount of investment and the returns from them cannot be

predicted with certainty due to certain variables like market for the product, technology,

government policies, etc.

The uncertainty associated with the investment and the returns is what makes decision

makers to consider probability distributions in their estimates, hence, making capital

budgeting to be considered under uncertainty and risk.

All the techniques of capital budgeting requires the estimation of future cash inflow and cashoutflow. The cash flow is estimated, based on the following factors:

Capacity of the project.

Depreciation cost.

Rate of taxation.

Future demand of the product.

Expect economic life of the product. Etc.

But due to uncertainties about the futures, the estimates of demand, production, sales, selling

price, etc., cannot be exact. To evaluate and select among projects that will maximize

owners wealth, we need to assess the uncertainty associated with projects cash flows. In

evaluating a capital project, we are concerned with measure of risk.


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The uncertainty arises from different sources, depending on the type of investment being

considered, as well as the circumstances and the industry in which it operating. Uncertainty

may due to:

Economic conditions.

Market conditions.

Taxes.

Interest rates.

International conditions.

STEPS INVOLVED:

Identifying the need of the project preparation of project report with respect to as follows:

Utilization.

Efficiency.

Capacity of the particular project.

Loss of market.

Loss of good will.

Technological requirements.

Justification based on money earnings.


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CHAPTER - 4

DATA ANALYSIS AND INTERPRETATION


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INTRODUCTION:

In Dr reddys a number of new projects are going on. Out of which 4 projects are selected for

the study. Some of the essential aspects of the projects are Depreciation Rate, Corporate

Income Tax Rate and The Discounting Factor. In this Dr reddys the Depreciation rate is

4.75% as their given, the Corporate Income Tax Rate is 34% (approximately) and the

Discounting Factor is 15% which is normally followed by the corporate houses. The

following table gives the abstract for these projects of the company.

SL.

NO.

PROJECT NAME BUDGET

ESTIMATES

DEPREC-

IATION

TAX PV

FACTOR

1. PROJECT 1 60 Lakhs 4.75% 34% 15%

2. PROJECT 2 25 Lakhs 4.75% 34% 15%

3. PROJECT 3 20 Lakhs 4.75% 34% 15%

4. PROJECT 4 10 lakhs 4.75% 34% 15%


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1. PROJECT 1

(Estimated Budget Rs 60 lakhs)

Calculation of Cash Flow after Tax (CFAT)

Calculation of pay back period:

The pay back period lies between 2 and 3 years. Therefore the exact pay back period will beas follows:

Pay back period = Base year + required CFAT

Next year CFAT

Exact pay back period = 2 + 6050.25

27.37

= 2 + 0.35

= 2.35

PBP = 2.35

Year 1 2 3 4 5 Total

EBDT 35.00 38.20 40.00 42.50 42.50 198.20

Less: Dep

@ 4.75%

2.85 2.85 2.85 2.85 2.85 14.25

PBT 32.15 35.35 37.15 39.65 39.65 183.95

Less: Tax

@ 34%

10.93 12.02 12.63 13.48 13.48 62.54

PAT 21.22 23.33 24.52 26.17 26.17 121.41

Add: Dep 2.85 2.85 2.85 2.85 2.85 14.25

CFAT 24.07 26.18 27.37 29.02 29.02 135.66

CCFAT 24.07 50.25 77.62 106.64 135.66


58/80

Calculation of ARR:

ARR = AVERAGE ANNUAL PAT 100

AVERAGE INVESTMENT

= 24.282 100

3

= 80.94%

ARR = 80.94%

Calculation of NPV:

PV of cash flow @ 15% = 89.75

Cash Out Flow = 60.00

Therefore to decrease the cash flow we increase the rate. Let the new rate be 18%

Year Cash Flows PV @ 15% PV of Cash Flows

0 (60.00) 1.00 (60.00)

1 24.07 0.870 20.94

2 26.18 0.756 19.79

3 27.37 0.658 18.01

4 29.02 0.572 16.59

5 29.02 0.497 14.42

Total Cash Flow 89.75

NPV 29.75

NPV = PV OF CASH IN FLOWPV OF CASH OUTFLOW


59/80

Calculation of IRR & IR:

The IRR is usually the rate of return that a project earns. PI measures the present value of

returns per rupee invested.

= 15 + 89.7560 (1815)

89.7583.48

= 29.2

IRR = 29.2%

= 89.75

60

= 1.49Profitability Index (PI) = 1.49 times


0 (60.00) 1.00 (60.00)

1 24.07 0.847 20.38

2 26.18 0.718 18.79

3 27.37 0.609 16.66

4 29.02 0.516 14.97

5 29.02 0.437 12.68


NPV 23.48

IRR = LR + (pv of cash flow at LR-pv of cash out flow) x (HR - LR)

(pv of cash flow at LR-NPV at HR)

PROFITABILITY INDEX (PI) = PV OF CASH INFLOWS

INTITAL CASH OUTLAY


60/80

2. PROJECT 2




EBDT 10.25 15.84 20.50 20.50 20.50 87.59

Less: Dep

@ 4.75%

1.1875 1.1875 1.1875 1.1875 1.1875 5.9375

PBT 9.0625 14.6525 19.3125 19.3125 19.3125 81.6525

Less: Tax@ 34%

3.08125 4.98185 6.56625 6.56225 6.56225 27.75385

PAT 5.98125 9.67065 12.74625 12.74625 12.74625 53.89065

Add: Dep 1.1875 1.1875 1.1875 1.1875 1.1875 5.9375

CFAT 7.16875 10.85815 13.93375 13.93375 13.93375 59.8281

CCFAT 7.16875 18.0269 31.9606 45.89435 59.8281


The pay back period lies between 2 and 3 years. Therefore the exact pay back period will be

as follows:


Next year CFAT

Exact pay back period = 2 + 25.0018.0269

13.93375

= 2 + 0.5 = 2.5

PBP = 2.5


61/80

Calculation of ARR:

= 10.77813 100

12.5

= 86.2%

ARR = 86.2%

Calculation of NPV:


0 (25.00) 1.00 (25.00)

1 10.25 0.870 8.9175

2 15.84 0.756 11.97504

3 20.50 0.658 13.489

4 20.50 0.572 11.726

5 20.50 0.497 10.1885


NPV 31.29604

PV of cash flow @ 15% = 31.29604


Therefore to decrease the cash flow we increase the rate. Let the new rate be 18%


AVERAGE INVESTMENT



62/80




= 15 + 56.2960425.00 (1815)

56.2960452.07587

= 37.23

IRR = 37.23%

= 56.29604

25

Profitability Index (PI) = 2.25 times


0 (25.00) 1.00 (25.00)

1 10.25 0.847 8.68175

2 15.84 0.718 11.373123 20.50 0.609 12.4845

4 20.50 0.516 10.578

5 20.50 0.437 8.9585


NPV 27.07587

IRR = LR + (pv of cash flow at LR-pv of cash out flow) x (HR - LR)

( pv of cash flow at LR -NPV at HR)


INTITAL CASH OUTLAY


63/80

3. PROJECT 3




EBDT 7.83 13.42 19.00 20.03 20.03 80.31

Less: Dep

@ 4.75%

0.95 0.95 0.95 0.95 0.95 4.75

PBT 6.88 12.47 18.05 19.08 19.08 75.56

Less: Tax@ 34%

2.3392 4.2398 6.137 6.4872 6.4872 25.6904

PAT 4.5408 8.2302 11.913 12.5928 12.5928 49.8696

Add: Dep 0.95 0.95 0.95 0.95 0.95 4.75

CFAT 5.4908 9.1802 12.863 13.5428 13.5428 54.6196

CCFAT 5.4908 14.671 27.534 41.0768 54.6196


The pay back period lies between 2 and 3 years. Therefore the exact pay back period will be

as follows:


Next year CFAT

Exact pay back period = 2 + 2014.671

12.863

= 2 + 0.4

= 2.04

PBP = 2.04


64/80

Calculation of ARR:

= 9.97392 100

10

= 99.73%

ARR = 99.73%

Calculation of NPV:


0 (20.00) 1.00 (20.00)

1 7.83 0.870 6.8121

2 13.42 0.756 10.14552

3 19.00 0.658 12.502

4 20.03 0.572 11.45716

5 20.03 0.497 9.95491


NPV 30.87169

PV of cash flow @ 15% = 30.87169


Therefore to decrease the cash flow we increase the rate. Let the new rate be 18


AVERAGE INVESTMENT



65/80




= 15 + 50.8716920.00 (1815)

50.8716946.92716

= 38.47

IRR = 38.47%

= 50.87169

20



0 (20.00) 1.00 (20.00)

1 7.83 0.847 6.63201

2 13.42 0.718 9.63556

3 19.00 0.609 11.571

4 20.03 0.516 10.33548

5 20.03 0.437 8.75311


NPV 26.92716

IRR = LR + ( pv of cash flow at LR -pv of cash out flow) x (HR - LR)

( pv of cash flow at LR -NPV at HR)


INTITAL CASH OUTLAY


66/80

4. PROJECT 4




EBDT 0.50 1.83 2.05 2.00 3.00 9.38

Less: Dep

@ 4.75%

0.475 0.475 0.475 0.475 0.475 2.375

PBT 0.025 1.355 1.575 1.575 1.575 6.105

Less: Tax@ 34%

0.0085 0.4607 0.5355 0.5355 0.5355 2.0757

PAT 0.0165 0.8943 1.0395 1.0395 1.0395 4.0293

Add: Dep 0.475 0.475 0.475 0.475 0.475 2.375

CFAT 0.4915 1.3693 1.5145 1.5145 1.5145 6.4043

CCFAT 0.4915 1.8608 3.3753 4.8898 6.4043


As the cumulative cash flows are less than initial investments of Rs. 10 lakhs, therefore the

cash flows are not recoverable in the project duration. For this project, the discounted pay

back period is not existed

Calculation of ARR:

= 0.80586 100

5

ARR = 16.11%

ARR = AVERAGE ANNUAL PAT 100AVERAGE INVESTMENT


67/80

Calculation of NPV:

As the total cash flows, are less than the out flows. The NPV is also negative. In this

situation, the company earning or internal rate of returns also negative. Even if calculated

IRR it will become an interactive and complicated process. It can better solved by the MIRR

method.

Calculation of IR:

= 4.4189

10

= 0.44



0 (10.00) 1.00 (10.00)

1 0.50 0.870 0.435

2 1.83 0.756 1.38348

3 2.05 0.658 1.3489

4 2.00 0.572 1.144

5 3.00 0.497 1.491


NPV (5.5811)


INTITAL CASH OUTLAY


68/80


69/80

INTERPRETATION:

When compare to all the 4 projects except the 4thproj ect i.e.,PROJECT 4 does not have the

PBP, because the project investment is not recover in the present cash flows, it shows the

negative value of the project, therefore the project should be rejected. Other 3 projects are

showing the positive values, therefore the projects are accepted.

In project 3 we can recover the investment with in a short period of time i.e.,

2.04 years, when compare with the other projects.

2.352.5

2.04

0

0

0.5

1

1.5

2

2.5

3

1 2 3 4

Project Pay Back Period

PBP

years

Projects


70/80

INTERPRETATION:

When compare to all the projects of ARR, in the 3 project i .e., PROJECT 3 the ARR % is

99.73%, so in this project the average rate of return is more.

When compare to all projects expects the PROJECT 4 i.e., project 4 is less thanthe companies minimum required rate of return.

0

20

40

60

80

100

120

1 2 3 4

Project ARR

p

ercentages

Project

Capital Budjeting Update-13(Raju Reddy)

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